Startups in Japan – Opportunities and Restraints

Defining what is a startup when compared to a small company could trigger long and heated conversations. In a nutshell, a startup is just a newly created company. The technological components might be more important than the coffee shop nearby. Startups usually carry a rapid potential for growth but also an increased risk of failure. They also often need external funding. In that sense, startups’ founders should cope well with the inherent uncertainties and risks associated with these endeavors. Japan’s economy is the third in the world by nominal GDP, the fourth by purchasing power parity. Japan ranks in the top 3 countries of the OECD statistics regarding tertiary education. Somehow, regarding startups and investments, Japan is far from being the leader we could expect from a technology-oriented, wealthy, and educated society. In this article, we will analyze what could be the key restraints and opportunities for the Japanese startup ecosystem.

KEY RESTRAINTS

The societal perception of Entrepreneurship: Founded in 1997 by Academics from Babson College and the London Business School, the Global Entrepreneurship Monitor (GEM) provides a comprehensive analysis of entrepreneurship in 54 countries. The 2018 Report offers surprising insights into the lack of entrepreneurs in Japan. The Entrepreneurship spirit index ranks in the last position….54 out of 54! The self-perceptions about entrepreneurship rank also 54/54 regarding perceived opportunities, capabilities, and intentions. The status of entrepreneurs is low, 48/52. Entrepreneurship is seen as a terrible career choice, 51/52. When asked why people do not want to start new businesses, fear of failure ranks high -18/54. In a country where the “salaryman” or white-collar workers’ culture is still vivid. In a corporate world where career advancement is even based mainly on the number of years spent in the same company, risky career plans are to avoid.

Human capital is relatively static in Japan: Long-term employment was once praised as one of the critical factors of Japan’s successful economic expansion. Recruited directly from universities, the employees could expect to safely stay in the same company during all of their careers. More than a working contract, the equivalent of a moral bond existed between the employee and his employer. Employees will commit and be faithful to the company. In return, the company will guarantee “lifetime employment.” It will not discharge or layoff employees unless some extraordinary circumstances are met, such as severe misconduct or to prevent bankruptcy.

Exit market: The rule of thumb is that in the US, 80 % of the startups will be acquired by larger firms who use M&A as an open innovation strategy. In Japan, this is just the opposite. Only 20% of the companies are acquired, leaving 80% of them with an IPO as the only possible exit option. The lack of late-stage funding. The more relaxed requirements to go public in Japan bring many companies to the market.  All of these factors contribute to the low valuation of the newly listed companies. i.e., Mothers is a Japanese market for startups or early-stage companies. Their revenues can be as low as $2 million, with a median of $22 million. On average, companies listed on Mothers will raise $11 million, with the smallest being $1 million. In 2018, nearly 2/3 of the IPO occurred on the Mothers market.

KEY DRIVERS

Opening Japan to the world: Historically, Japan has long been a closed country. For years the primary market and sometimes only market was domestic. In the age of the Internet, things are changing. Companies need to open themselves to foreign markets. To keep pace and innovate, big Japanese corporations are more and more prone to investing in startups. Toyota, Panasonic, Sony, and Softbank committed large amounts of money in AI, Robotics, IT, Internet of Things, and autonomous driving. Innovation ROI is often difficult to measure, especially with Open Innovation strategies. It is somehow the path to follow to maintain an innovation momentum within well-established companies. Venture capital investments in startups in Japan reached a record high of $2.5bn in 2017. It could appear like a large amount of money, but it only represents three percent of the VC funding in the United States.

Government Support: Japan’s government is now actively supporting and promoting startups to develop internally and externally. The Ministry of Economy, Trade, and Industry (METI) started in 2018. A new program called the “J-Startup” program. Selected Japanese startups will benefit from special incubation programs. They will also receive support from the Japan External Trade Organization (JETRO) to promote the products and services on a global level. The vision for this program is to establish 20 new venture businesses, or Unicorn, with a corporate value or market capitalization of over 1 billion dollars, by 2023.
METI and JETRO opened in 2015 the Tokyo based One-Stop Business Establishment Center (TOSBEC) to support foreign companies and start-ups fill up the necessary documents to incorporate a new company. Various services are provided, such as interpretation or consultations on management, financials, taxes.
Space startups can also benefit from the $940 million funds that the Government allocated in 2018. Over five years, eligible startups will receive up to 10 million yen each in investment or loan to cover research or patent application costs.

The search for the next Unicorn: The massive success of Mercari’s IPO may well be the unicorn Venture Capital was looking for in Japan. The online used items sales platform brought considerable rewards to early investors. It attracted more institutional investors, such as the Government Pension Investment Fund (GPIF), the world’s largest pension fund, and the Pension Fund Association of Japan to explore Venture Capital investments in domestic companies.

In Japan, Entrepreneurship and startups have still a long way to go. With falling demography, an aging population, and a new generation of students who were raised watching American TV dramas and browsing the Internet, no doubt that the mentalities are changing. Formatted domestic careers will soon be anachronic. Political and economic tools are slowly getting in place. The real challenge will be to change the mindset and bring innovation and more early-stage money to the VC table.